When Is (Performance-Sensitive) Debt Optimal?

34 Pages Posted: 18 Aug 2021

See all articles by Pierre Chaigneau

Pierre Chaigneau

Queen's University

Alex Edmans

London Business School - Institute of Finance and Accounting; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Daniel Gottlieb

London School of Economics

Date Written: August 1, 2021

Abstract

Existing theories of debt consider a single contractible performance measure ("output"). In reality, many other performance signals are also available. It may seem that debt is no longer optimal; for example, if the signals are sufficiently positive, the agent should receive a payment even if output is low. This paper shows that debt remains the optimal contract under additional signals -- they only affect the face value of debt, but not the form of the contract. We show how the face value should depend on other signals, providing a theory of performance-sensitive debt.

Keywords: informativeness principle, limited liability, performance-sensitive debt

JEL Classification: D86, G32, G34, J33

Suggested Citation

Chaigneau, Pierre and Edmans, Alex and Gottlieb, Daniel, When Is (Performance-Sensitive) Debt Optimal? (August 1, 2021). European Corporate Governance Institute – Finance Working Paper 780/2021, Available at SSRN: https://ssrn.com/abstract=3895702 or http://dx.doi.org/10.2139/ssrn.3895702

Pierre Chaigneau (Contact Author)

Queen's University ( email )

Smith School of Business - Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

Alex Edmans

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
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London NW1 4SA
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Daniel Gottlieb

London School of Economics ( email )

New Academic Building 5.30
Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://https://personal.lse.ac.uk/gottlied/

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